How the mortgage interest deduction could change

Congressional action on the U.S. tax code could dramatically alter one of its sacred cows: the mortgage interest deduction. And the change could come in 2013.

House Ways and Means Committee Chairman Dave Camp (R.-Mich.) held tax reform hearings in April to eliminate loopholes. He said he's "carefully looking into revising" the popular provision that many in the real estate business consider crucial to the industry.

Camp said he'd like a total tax reform package before the year is out.

One analyst says the time is ripe to change the deduction—in existence since 1913— which is costing the U.S. government billions in tax revenue while doing little to help home ownership.

"It costs at least $70 billion a year in lost tax revenues," said Will Fischer, a senior policy analyst at the Center on Budget and Policy Priorities, and co-author of a study released last month that called for changing the mortgage interest deduction intto a tax credit.

"It only benefits about half of homeowners that pay interest," Fischer said. "I think there's real interest in reforming the mortgage interest deduction to help more people, while bringing in more tax revenue."

Upper Income Families Biggest Beneficiaries

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Right now, taxpayers who itemize their deductions, can deduct their mortgage interest on up to $1 million of home acquisition debt, plus up to $100,000 of home equity loans, a type of loan in which the borrower uses the equity in their home as collateral. The amounts can include both primary and secondary homes.

In his paper, Fisher states that in 2012, 77 percent of the benefits from the mortgage interest deduction went to homeowners with incomes above $100,000. Close to half of homeowners with mortgages—mostly lower and middle-income families—received no benefit from the deduction, according to Fisher.

Only about 30 percent of eligible taxpayers actually use the mortgage interest deduction each year.

"You can make the case for the deduction, but it really does promote home ownership for mostly upper income levels," said Mark Goldman, a real estate professor at San Diego State University.

"And I've never had a deal happen or not happen because of the deduction," added Goldman, who is also a real estate broker.

How It Could Work

Fischer's study points to several bipartisan panels that have looked into changing the deduction into a tax credit.

They include the Simpson-Bowles fiscal commission, as well as a tax reform group during the first term of president George W. Bush, and a debt reduction commission headed by former Democratic White House official Alice Rivlin and former New Mexico Republican Senator Pete Domenici.

The various proposals would have a tax credit from a low of 12 percent to a high of 15 percent, without the need for taxpayers to itemize their returns. The proposals would limit the mortgage interest covered in the credit up to $500,000, or half of what it is now. All but one of the major proposals would eliminate the tax credit for a second home.

"A tax credit is a much fairer way to help homeowners, especially those that need it, like lower income families," argued Fisher.

But some heavy hitters in housing say changing the deduction in any way is unthinkable.

"We think it should stay exactly the way it is," said J.P. Delmore, a lobbyist for the National Association of Home Builders.

"The deduction helps promote home ownership and we're against any changes into a tax credit," Delmore said. "Eliminating it would really be a tax hike on homeowners."

"There are winners and losers in every scenario but there would be more losers with a tax credit,"said Robert Dietz, a tax economist at the NAHB.

"Home prices would likely come down if there is no deduction, as there would be fewer buyers," he said.

The National Association of Realtors said in a statement that, "Home prices, particularly in high cost areas, could decline 15 percent if recommendations to convert the mortgage interest deduction to a tax credit are implemented."

"The deduction means more to people than a credit," said said Johnny Martinelli, an associate real estate broker at Don Cies Real Estate in Norman, Oklahoma.

"Especially for first-time home buyers who may pay more interest at first than someone who's been in there home a long time and are paying more principle than interest," he said.

"It's a nice benefit to have when thinking about buying a home," Martinelli added.

Mixed Record in Other Countries

Proponents of killing the mortgage interest deduction point to Canada and Great Britain as examples of how it could work.

Canadian federal income tax does not allow a deduction from taxable income for interest on loans secured by the taxpayer's personal residence. Homeownership in Canada rose to a high of more than 69 percent in 2012.

Great Britain phased out the deduction starting in the 1980's and ended it completely in 2000.

Home ownership in England will slump to just 63.8 percent over the next decade, down from 72.1 percent in 2001, according to studies. Reasons for the fall include the need for huge deposits, combined with high house prices and strict lending criteria.

"Your're seeing how the lack of a deduction is affecting first-time home ownership in Britain," said Delmore of the NAHB. "The average age for first-time homeowners is getting older. It's up from 31 to 38. It shows how important the deduction is for those first timers."

Future of Deduction

More hearings on tax reform are scheduled through the summer and autumn, but forces attempting to enact mortgage deduction reform in Congress and the White House won't find it easy going.

Representative Sander Levin, the top Democrat on the House and Ways Committee, said he is "wary of eliminating the tax break for second homes." He told reporters that many residents of his district in central and northern Michigan have "small second homes" elsewhere in the state.

Fellow committee member Rep. Linda Sanchez, (D-CA) said she wants to make sure changes won't make it more difficult for working-class families to afford a home.

"I'm a little bit skeptical of changes to the tax code that would have the effect of putting that goal out of reach," she said to reporters after the June hearings.

For his part, President Obama has proposed ending the deduction for people above the 28 percent income tax bracket. That would mean that a homeowner in the top tax bracket with $10,000 in mortgage interest would receive a tax break of $2,800, as opposed to the $3,960 they currently get.

"You can't say for sure what will happen in Congress, but I think there's a lot of momentum to finally change the mortgage interest deduction," said Fischer. "When you look at all the ideas for tax reform, this one stands out for action."